When markets go up, more investors take notice. It's only natural for people whose money has been on the sidelines to see headlines about the S&P hitting new highs and decide they want a piece of the action.
Companies that offer investment services, such as Legg Mason (NYSE:LM), can benefit greatly during times like these, and for several reasons.
Let's take a look at how the improving economy helps these companies, and why Legg Mason in particular could be an excellent spot to invest relative to its larger peers such as BlackRock (NYSE:BLK) or Franklin Resources (NYSE:BEN).
A double benefit
When the economy is thriving, there are a few ways investment managers tend to increase their profitability. First, and most obvious, is the rising value of the company's assets under management, which generates additional income through commissions and interest.
For instance, if a certain investment management company has $1 billion under management and the market rises by 20%, now they have $1.2 billion under management from which to generate commissions and returns.
Second is increased trading volume (commissions) that comes with the shift into equities that goes along with rising markets.
It has been mentioned in the news that the shift into equities has been more apparent recently, with industry experts largely believing there is more cash on the sidelines that will be moved into stocks, ETFs, and other more aggressive investment vehicles over the next few years. Specifically, a market like the current one favors buying individual stocks, which is an excellent source of commissions.
Why Legg Mason?
Legg Mason has about $645 billion in assets under management, with the majority (55%) comprised of fixed-income assets. About 25% of assets are equities, and the other 20% are liquidity assets (cash and equivalents). I love the asset blend because of the potential to benefit from a shift into equities, as three-quarters of assets are in other investment vehicles.
The relatively high percentage of cash assets also creates an excellent opportunity to benefit from the current low interest rate environment. There is a pretty wide spread right now between the interest the company must pay to depositors and the interest that can be earned by loaning said money out (such as to margin accounts).
With Legg Mason's stock up by about 16% in the past month and by almost 60% in the past year, it may seem like the time to get in has passed. On the contrary, I believe the share price is simply beginning to reflect the benefits of the current economy I mentioned earlier. On a valuation basis, Legg Mason is still an extremely attractive company, and even more so when compared to some of its peers.
For its current fiscal year, Legg Mason is expected to report earnings of $2.26, meaning the stock trades for 17.5 times this year's earnings, which sounds a bit expensive. However, consider that the consensus calls for annual earnings growth of 17% and 20% for the 2015 and 2016 fiscal years, respectively. This is an excellent growth rate that more than justifies the stock's current price.
The other guys
One of the biggest companies in the investment management sector is BlackRock, whose $4 trillion in assets under management has been growing at a rapid pace. Before we get to the company's valuation, consider that BlackRock's assets are 52% equities, 30% fixed-income, 12% other investments, and just 6% in cash and equivalents. So, right away, I'm inclined to say that BlackRock doesn't stand to benefit from the expected shift into equities as much as Legg Mason could.
At almost 19 times this year's earnings, BlackRock is also a little more expensive than Legg Mason, which is even more apparent considering its 13% forward earnings growth rate. While this isn't overly expensive by any means, especially considering the growth in assets under management, it is certainly pricier than Legg Mason.
Another leader in the sector is Franklin Resources, which has even less of its assets in liquid investments (just 1%). The fact that fixed income and equities are about equal (43% vs. 40%) tells me that there may be more room to benefit from a shift into equities than BlackRock, but a lack of cash assets is a cause of concern for me.
As far as its valuation goes, however, Franklin is looking rather cheap at just 14 times its current year's projected earnings, which are supposed to rise by about 11% annually over the next few years. Legg Mason is still the better-priced option, in my opinion, because of its more favorable growth rate to P/E ratio.
Not only does Legg Mason trade for an incredibly attractive valuation, the distribution of its assets under management put the company in the best position to benefit from both the shift into equities as well as the low interest rate environment.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends BlackRock. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.